Friday, June 5, 2015

How to find profitable companies: My Personal Strategy for Picking Stocks

I have always believed that investing is very personal. We each have our own individual strategies that work for us and with which we feel comfortable. Some people thrive with trading and truly enjoy the process of looking at charts, buying and selling stocks all day, with no attachment whatsoever.

Others (like myself) actually enjoy the idea of being a "part owner" of a company for a while and benefiting from that through dividends and stock price appreciation over time.

I recall a very intelligent finance professor I had in graduate school whom shared with the class that he could never be a long term investor. He said the longest he has ever held a stock in in his life was about 2 weeks and he lost so much money he went back to trading, which is something he is good at.

As you can see-- whether you are a long term or short term investor, someone just starting out, a college professor, or anything in between; what is important is to know yourself and your risk tolerance. I explained in a past post why I prefer long term investing over trading (check it out here if you missed it).

So anyways, the other day I took a close look at my portfolios and realized that nearly every single company in which I have shares (specially those stocks with the highest return on investment) have very specific factors in common. I decided to share them here and see whether we all agree or disagree on said factors. 

Also, would love to learn more about other people's strategies when it comes to choosing stocks (for the long term or short term) and what works for others. 

Here's what I look at when choosing 'winning' stocks (with some examples):

1. Leadership position within the company's respective industry (I.e:. largest market share and/or highest level of popularity/following among consumers).

For instance, Apple (AAPL) V. Android. Have you ever witnessed hundreds or thousands of people making a line weeks in advance for an Android phone? How about for an Apple devise? This is what's ironic- Android has the highest market share in hand held devices worldwide V. IOs, by a substantial amount. According to a study by the International Data Corporation published in August 2014; Apple's market share for the iOS is a mere 11.7% while android's market share is an staggering 84.7%.  

How is it that Apple (iOS) system is more popular and more profitable?The market share situation is offset in part due to the fact that Apple's products are a lot more expensive than Android. The combination of their pricing power and brand is so strong, that most individuals have no problem paying a premium for Apple and this is why it's become one of the most powerful companies and brands in the world-  "Apple charges much more for its phones than Android's maker's do, and takes a huge profit of the world's smartphone profits by doing so. Apple doesn't actually want buyers who seek the cheapest, least-profitable phones. And its customers tend not to want Android products". Source

2. Clear, specified plans on how the company will maintain their competitive advantage through ongoing innovation, growth, and further developments.

Google (GOOG), for instance, is a company that has been "morphing" slowly but surely over time. Although it remains the king of advertising, this is something that is slowly changing due to competition. Nonetheless, Google has very exciting and clear plans on how they will continue innovating the world and this is demonstrated each and every time they launch a new project to the public. New developments and upcoming launches were announced in their most recent I/O conference.

3. Several years of existence in their industry (sometimes centuries) and the ability to adapt in changing times. Companies like Johnson & Johnson (JNJ) fall in to this category. This is a company with a portfolio of hygiene and health care products that has gained the trust of consumer and is a trend that has continued generation after generation. The company has been around for 120 years and counting. 

4. Very little competition, if any- Disney (DIS), for instance, I see as a stand alone company with a very unique positioning in terms of the industries where it competes. A couple of other companies in this category include Visa (V) and Mastercard (MA), these companies have a semi-duopoly when it comes to the payment processing industry.

5. Companies that sell products of provide services that people need regardless of what may be going on in the economy or in the world.

Whether or not the world or the economy may be falling apart, we all need to brush our teeth, wash our face, wash our hair. Companies like Colgate (CL) and Procter & Gamble (PG), just to name a couple, are the type of long term investments that can help us hedge against downturns in the economy

6. Healthy financial statements (including minimal debt, if any, top line and bottom line growth year over year through a good amount of time). A good rule of thumb question to look in to- How did this company perform during the financial crisis?

7. Company pays dividends- I am a huge advocate for dividends. Dividends are awesome for obvious reasons-- not only can you benefit from stock price appreciation but the company also pays you ever 3 months for holding shares. Doesn't get any better than that. I would say about 80% of the companies in my portfolio and those I manage pay dividends.

8. The leadership, management, and company's culture- I strongly believe the management team is just as important as anything else when it comes to evaluating a company. I sometimes look at factors on whether or not the founders of the company are still part of the board, how long management has been in place, the compensation package for CEO and executive board (you can find that by reading the proxy statement of any company), age of the CEO and its commitment to the company, are benefits packages tied to company's performance or irrelevant? these are just some of the factors that may be important to look in to simply to ensure that the people leading the company are equally (or more)  invested in the company's long term success as the shareholders. 

My Thoughts on Valuation: This is a more advanced topic which I will discuss in an upcoming post as I'd like to explain the basics to my investing 101 followers before I get in to more technical information. Nonetheless, my general opinion on valuation is that it is not the end all be all when it comes to choosing stocks and sometimes valuation numbers take a back seat when it comes to exploring the true value of a possible investment. For instance, if investors would have focused on valuation when companies like Amazon (AMZN) first came out, they would have missed out on the fact that the stock price has ascended over 1,000% since its IPO. Why? because there was nothing like Amazon when it first entered the market and so, 'skepticism', about future prospects yet a promising hope for the tech giant caused valuation to scare away many. This great post by NYU professor Damodaran provides some additional insights on the topic. 

Now, let this simmer in for a while-- had you invested $1,000 in AMZN back in 1996, you would have about $247,540 sitting in your portfolio today. Hence, although valuation is important, investors should be careful in letting it determine whether or not they invest on something and it depends highly on the type of company and industry we may be analyzing. 

And that's all folks! Keep in mind that the above noted points are not the end all be all in terms of metrics to look at when investing in a company. Every company is different and things can change drastically forcing us to look at other important factors. It is important to be flexible and adjust. However, these are some of the factors I look at and what has worked for me personally.

Tell me, What is your investing strategy? what factors are important to YOU?

Thanks for reading & Cheers to profits!


Disclosure: I am long on AAPL, GOOG/GOOGL, CL, PG, MA, V, DIS, JNJ.
Do not invest or cease to invest solely based on the information in this post.